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Private Split Dollar Rescue Opportunities
One of the life insurance industry's "little secrets" involves illustrations of a survivor life policy in a private limited collateral assignment split dollar situation in which both insureds are assumed to remain alive for all years illustrated when the more likely event is that one insured will outlive the other by several years. When the first death occurs, there is a marked acceleration of economic benefit costs caused by the use of "single life" economic benefit rates. Typically, this condition is not covered in the illustration. At first glance, a rollout might solve the problem except as noted above, the only way to rollout a private collateral assignment split dollar plan is to transfer the sponsor's interest to the trust. Anytime the lifetime exemption is used prematurely, it ultimately will cost a substantial estate at least 45 cents on the dollar in additional estate taxes (unless we consider a convenient death in the one year of estate tax repeal in 2010). There is a substantial amount of private limited collateral assignment split dollar in force. To avoid the acceleration of economic benefit costs associated with the first death, all such plans should be converted to one of the new "loan regime" plans authorized by IRS Notice 2002-8 and the proposed split dollar regulations issued in July 2002. This is because the loan interest associated with these plans is neither age-based nor multiple-insured based. InsMark calls the private variation of such plans a Private Leveraged Benefit PlanÔ , and it can be illustrated in the InsMark Section 7872 Illustration SystemÔ (along with their employer-sponsored cousin, the Leveraged Benefit PlanÔ ). To understand the reasons for conversion of an in-force private limited collateral assignment split dollar plan to a Private Leveraged Benefit Plan, the following Tables should be instructive. The data below involves an actual case of a $5,000,000 level face amount survivor universal life insurance policy with scheduled annual premiums of $50,000 issued February 20, 2001 (issue ages 65/60). With that policy subject to a private limited collateral assignment split dollar arrangement, Table 1 reflects the effect over the next 30 years of the sponsor paying its premium share and gifting the trust the money for its premium share. Table 1
*Including annual gifts to the trust for its premium
share. Column (6) in Table 1 is caused by the fact that even though survivor life economic benefit rates are being used, starting in year 27, the plan's economic benefit exceeds the entire policy premium thereby creating gifts of a future interest of $102,680 over the remaining four years of the illustration. You can see the year-by-year detail of this in Column (4) on Page 11 of the accompanying illustrations (click here to view the illustrations). The problem would worsen considerably if the plan remains in effect longer than 30 years. The policy could be rolled out earlier. This would lessen the problem; however, the trust would then be required to pay the policy's $50,000 annual premium and, of course, the sponsor would need to make non-recoverable gifts of this amount to the trust. The problem gets even worse. Assume one of the insureds dies in year 15, after which the split dollar plan loses its use of survivor life economic benefit rates, and single life term rates must be substituted thereafter. You can see the disaster pending in Column (6) in Table 2. Table 2
*Including annual gifts to the trust
for its loan interest. Column (7) in Table 2 displays the financial horror show of a rollout. Thanks to IRS Notice 2002-8 and the proposed split dollar regulations, if the plan is rolled out to the trust in year 30, for example, the policy's cash value of 1,588,098 will be a gift of future interest to the trust not subject to Crummey offers. The surviving spouse's entire lifetime gift exemption of $1,000,000 will have already been used up (and then some) by the gift taxes associated with the numbers in Column (6), and the rollout in year 30 would trigger gift taxes on $1,588,098 -- not a pretty picture. You can see the year-by-year detail of this in Column (4) on Pages 12 and 13 of the accompanying illustrations (click here to view the illustrations). The problem would worsen considerably if the plan remains in effect longer than 30 years. Now examine an alternative approach in which the private limited collateral assignment split dollar plan is converted to a Private Leveraged Benefit Plan, a "loan regime" plan in compliance with IRS Notice 2002-8 and the proposed split dollar regulations. Table 3 summarizes the results over 30 years (2 years of split dollar followed by 28 years of loans) in which the sponsor: 1) converts the two years of the sponsor's prior split dollar premium advances to a loan and 2) loans the trust the funds needed to pay the remaining policy premiums as they fall due. In addition, Table 3 reflects the cost of gifting the trust the funds needed for its loan interest payments. Table 3
*Including two years of split dollar advances converted
to loans. The reason that the Private Leveraged Benefit Plan illustrated in Table 3 has no entries in Column (6) is because the loan interest associated with the plan is not age-based as are the economic benefit rates associated with private limited collateral assignment split dollar. This is one of the very good pieces of news present in IRS Notice 2002-8 and the proposed split dollar regulations. The new loan regime plans like the Private Leveraged Benefit Plan offer a solution to one of the serious problems associated with older age split dollar plans. There is a vast number of in-force private limited collateral assignment split dollar plans -- you should search every one of them out and convert each of them to a Private Leveraged Benefit Plan. In addition, as this report proves, no new private limited collateral assignment split dollar plans should be written. Instead, the Private Leveraged Benefit Plan should be utilized. There is simply no valid comparison. (See the article entitled The Private Leveraged Benefit Plan in this Series for an analysis of a Private Leveraged Benefit Plan that is not the result of a conversion of an in-force split dollar plan (click here to view the article now).) Loan Interest Rates: For illustrative purposes, the Private Leveraged Benefit Plan illustrations shown in this report reflect the February 2003 long-term Applicable Federal Rate established under IRC Section 7872 of 4.85%. In reality, the loan interest rate for each new loan will likely be different, and each future loan must bear its own AFR that is in effect during the month each new loan is executed. There are several ways to deal with an unknown future AFR; however, one of the most effective is renegotiating the loans if interest rates fall. Renegotiating is a powerful strategy, and an analysis of the historic AFR is instructive as shown in Table 4 below. Table 4
If, for example, a policy had been purchased in 1993 and, through several strokes of bad timing, the loan for each of the first 10 premiums had been made at the highest rate that occurred during each of the next 10 years, the average loan interest rate on the composite of all loans would end up at 6.91%, as shown in Table 5 below. Table 5
However, if each loan had been renegotiated at the lowest rate available over the subsequent years, a far different result would have been produced, as shown in Table 6. Table 6
This example (which may not be representative of interest rates over all 10-year durations) reduces the long-range loan interest rate on a regular basis. By the tenth year (2002), it would have been permanently reduced from 6.91% to 4.73%, a 32% reduction -- significant indeed for a series of loans scheduled to stay in force over many years. Any future dips in the AFR below 4.73% could lower it further, and future spikes would not affect it. Note: Loan interest rates greater than the current AFR may be illustrated with the Private Leveraged Benefit Plan in order to provide a comfort zone in the initial illustration for those clients concerned that the AFR might spike over the years in which loans are scheduled. A final thought on loan interest renegotiations: Many homeowners have refinanced their home mortgage interest rates downward over the last several years -- in some cases, more than once. There have been dozens of opportunities to do so as rates have fallen; however, the decision to act was controlled to a great extent by 1) the hassle and 2) the costs associated with refinancing, e.g., appraisal fees, points, etc. Imagine if there had been no hassle and no costs -- just a simple form to sign. Under these circumstances, imagine how many times the refinancing would have taken place. It is just that simple to renegotiate the loan interest rates on a plan funded with loans at the long-term Applicable Federal Rate. How do clients keep track of the rates? If a client elects to have his/her plan administered by the web-based InsMark Section 7872 Administration System, a monthly e-mail will be sent outlining each month's new rate and whether any in-force loans are at higher rates. Illustrations: The illustrations for the private limited collateral assignment split dollar plan are on Pages 1 through 13. The illustrations for the Private Leveraged Benefit Plan are on Pages 14 through 26. Please study the two-page Highlights of the Plan on Pages 14 and 15 carefully to acquaint yourself with the nuances of this superb new planning technique. Click here to view the illustrations. You can reflect the current receivable (premium advances) from an in-force split dollar plan being converted to a loan in the Private Leveraged Benefit Plan under the "Loan and Gift Data" tab under the column heading "Prior Private Split Dollar Payments Converted to Loans". The System recognizes this amount as part of the initial loan that funds the Private Leveraged Benefit Plan. To see how we handle this, on the Summary of the Plan (Page 20), note the initial figure in Column 2 as well as the upper left footnote at the bottom of the page (click here to view the illustrations). Note: One difference between the Summary pages of the two sets of attached illustrations may be confusing unless we bring it to your attention. The executive's share of policy values in the private limited collateral assignment split dollar plan is shown net of the employer's interest in the plan. With the Private Leveraged Benefit Plan, we show the trust's gross policy values that collateralize the loans associated with the plan -- a change of format we deliberately made in the designs for the Private Leveraged Benefit Plan; however, to make the comparison easier for you, the trust's net policy values reflected in Table 3 above are illustrated after deducting the loans. Licensing: Both the Private Leveraged Benefit Plan and the Leveraged Benefit Plan (cast between employees and valued executives) are available in the InsMark Section 7872 Illustration System. (The Leveraged Benefit Plan was featured in the last report in this Series.) The InsMark Section 7872 Illustration System is available for licensing now. Please call an InsMark Account Executive at 1-888-InsMark (467-6275) for details, or click here. Insurance companies and other institutional firms interested in multiple unit or site licensing should contact David A. Grant, Senior Vice President, Sales, at 1-925-543-0500, extension 513. Specimen Documents: Licensees for the InsMark Section 7872 Illustration System are furnished with several specimen documents used to establish the loan transactions. Workbooks: Licensees for the InsMark Illustration System can review all reports and related menu inputs for the accompanying private limited collateral assignment split dollar plan illustrations by selecting the Workbook named MA147.!II from this website. Licensees for the InsMark Section 7872 Illustration System can review all reports and related menu inputs for the accompanying Private Leveraged Benefit Plan illustrations by selecting the Workbook named MA147.!LB from this website. To go to the Workbook download page on our website, click on Producer's Center; then on Workbook Download (one of the icons at the top of the page). After you download the Workbook files, you can import them into their respective Systems by clicking on Client Workbook / Import Workbook on the main menu bar. Click here to download the Workbooks now. Important Notice: In all cases, the approval of a client's legal and tax counsel must be secured before implementing a Private Leveraged Benefit Plan. P.S. In the next report, we will examine how a parent (or grandparent) can use the Private Leveraged Benefit Plan to help heirs acquire substantial life insurance coverage on their own lives on an unusually favorable basis [Rev.4-24-03] |
